Are You in the Income Based Repayment Plan?

If you are in the Income Based Repayment Plan (IBR), I would like to ask you to do a little homework about your financial situation and the potential damage you might be doing to yourself in IBR.

IBR provides a fairly small monthly payment if you have a large student loan relative to your income. It helps you when you are in a tough spot financially. The problem is it can also tempt you to get into the program when you have large student loans even when you are making pretty good money.

Question #1 – Are you in IBR because you are experiencing a serious income problem?

IBR can be a great way to address a temporary financial crisis. If you cannot make the normal monthly payment on your student loan, IBR can reduce the payment to a level that is manageable. It can basically buy you some time while you are working on getting your income back up. On the other hand, if you are making pretty good money but you have a large student loan balance, you may just be making your debt problem worse by being in IBR.

Question #2 – Is your monthly payment in IBR covering the monthly interest?

Look up how much interest is due on your loans each month. If your monthly payment is less than that amount, you are basically digging yourself a deeper hole every single month. The amount of principal plus interest due on your loans is going up every month. That’s a recipe for disaster if you allow it to go on for long.

IBR can be a blessing or a curse. It all depends on your current situation and whether you have a well thought out plan for getting the debt paid off.

Don’t go into IBR without knowing how it works. You need a plan that takes into account the reality of your current situation and how you plan to eventually get your student loans paid off.

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The new Pay As You Earn student loan repayment program – a blessing or a curse? Part 1

Big changes are on the way in how student loan repayment works. And they are going to make your job of parenting even harder (in a twisted sort of way).

If you’re a big believer in the value of debt, you’re going to love these changes. If you’re the kind of parent who teaches your children that debt, at least generally speaking, is not a good idea, then you may struggle with how to advise your children when college time approaches.

The changes are part of an executive action president Obama announced called Pay as You Earn.  It is very similar to the new changes coming in the existing Income-Based Repayment (IBR) program.

Pay As You Earn (PAYE)

PAYE redefines how student loan repayment will work. Its provisions are generally effective at the end of 2012. In PAYE, your monthly student loan payment is based almost exclusively on your income after college, regardless of how much student debt you owe when you get out of school. Then any balance, including accrued interest, that is still due at the end of 20 years is forgiven by the government.

The program has its roots in President Obama’s State of the Union address on January 27, 2010, where he said this:

“Let’s tell another one million students that when they graduate, they will be required to pay only 10 percent of their income on student loans, and all of their debt will be forgiven after 20 years – and forgiven after 10 years if they choose a career in public service, because in the United States of America, no one should go broke because they chose to go to college.”

The program is designed to reduce the required monthly payment on a borrower’s student loan based on their income. Generally speaking, if your monthly payment under a 10 year repayment period is greater than the monthly payment PAYE calculates, then you qualify for the program and you make the lower monthly payment.

The monthly payment under PAYE is calculated as 10% of your discretionary income. It defines your income as your Adjusted Gross Income on your federal tax return. It defines discretionary income as 150% of the poverty line for a family of your size. For a single person with no children, the poverty line in 2012 is $11,170. 150% of that number is $16,755. (Those amounts go up if you have children.) So it looks at the difference between your income and the $16,755 to calculate what the government feels you can use to make a monthly payment.

A Borrower Example

A single person with no children making $30,000 (assuming AGI is also $30,000), that comes out of school with $25,000 in student loans, would have a monthly payment of $110. Under the 10 year repayment plan your monthly payment would have been $289. Since the $110 is lower than the $289, you qualify for the plan and would make the lower monthly payment. Any balance still remaining after 20 years would be forgiven by the government.

Here’s a biggie…

The $110 monthly payment in this example would not change even if you graduated with $50,000 in debt (rather than $25,000). It wouldn’t change if you graduated with $100,000. You could graduate with $250,000 in student debt and it would not change the monthly payment as long as the student loans are all loans made by the government. (Note: to get student debt that high through the government would mean you went on to graduate or professional studies after your undergraduate degree.)

Private student loans are not eligible for this program. Parent PLUS loans are not eligible either.

PAYE is setting the monthly payment based almost entirely on your income.

The Good, the Bad and the Ugly

Stay tuned for Part 2 (and beyond) on this subject.

I will list all the good and the bad points that the new Pay As You Earn program and the new IBR program create.

Some are really good… and some are really bad.

The key is for you to determine how this will impact you and your children. That’s what’s most important. I’ll help you accomplish that.